We’re often told these days that we must take more responsibility for our own financial futures.
And we must! This site partly exists to help.
Taking responsibility is pretty straightforward – simple, but not easy – if you’re spending more than you earn, or you haven’t saved a rainy day fund.
Like a vasectomy, it’s a matter of cutting the outflow and redirecting internally.
But once you’re free of debt and you’ve got 3-6 months in a cash emergency fund, the picture gets more complicated.
Not with the part most people fret over – how to invest. That’s a solved problem.
Invest in a global index tracker fund, offset the risk with an appropriately-sized slug of government bonds, do it in tax shelters (ISAs and pensions), use cheap platforms, and add more monthly – rather than fuss daily – for the next 30 years. Tweak to suit.
Yes we like to dig into the minutia around here – exactly which fund, how much in what bonds – but you won’t go wrong if you get the basics right.
The big picture
Things get tricky not with the tactics…
Index funds, platforms, tax shelters
…but with the strategy…
How much to save? When can you retire? What can you spend?
We’ve written many series on everything from doing your planning to estimating a sustainable withdrawal rate.
They’ve typically come in multiple installments, because there are no pat answers.
Indeed faced with more complexity, many people are tempted to turn to professional advice.
And when it comes to issues such as taxes or estate planning, seeking advice could be very wise.
However I’m usually wary of suggesting people re-introduce higher costs and murkiness back into their core financial planning by offloading responsibility to a third-party.
Unless you’re very wealthy, such advice will probably just be outsourced to software – albeit someone charming who might spend an hour explaining the system’s output to you, and if you’re fortunate help you with the inputs.
But it won’t be truly individual advice, typically.
This is a problem, because such software models can spit out very different numbers.
Pension planning: from plenty to penury
Consider the results of an investigation into online pension planners by Trustnet’smagazine this month, pointed out to me by reader P.J.:
After almost two solid days on five platform websites, I have to say I was surprised to see there was almost no agreement at all on what my money would provide in retirement.
I am now wondering if the calculators are plain wrong, steeped in regulatory pessimism or a victim of their own complex assumptions.
The range of results is pretty astonishing, in some cases suggesting your income will run out 15 years earlier from what are essentially the same inputs.
The article’s author John Blowers fed the same fairly standard retirement scenario into all five planners. The results that came back do appear to be… a mixed bag:
There are some huge variations in there! Read the full article for more about the assumptions, and a discussion of what might be going on.
I’d suggest you do the hard miles with your own pension calculations. You can then sanity check them with an online planner or two.
If nothing else you’ll be better able to understand how these tools reach their conclusions!
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Well, that’s odd! The Slow & Steady passive portfolio is up year-to-date, by 2.7%. It’s up over the past twelve months by 6.4%. I’ll take that.
It feels unreal to be talking about those kinds of returns as a global recession sweeps our economic shoreline like a tsunami. Can our chums in the world’s central banks hold back the waters long enough for most of us to scramble to higher ground?
For now, let’s just double-take at the numbers that few would have predicted three months ago. Quarterly returns brought to you by Miracle-o-vision:
The Slow and Steady portfolio is Monevator’s model passive investing portfolio. It was set up at the start of 2011 with £3,000. An extra £976 is invested every quarter into a diversified set of index funds, tilted towards equities. You can read the origin story and catch up on all the previous passive portfolio posts.
Too good to be true?
The fate of our portfolio is largely driven by its two biggest holdings: Developed World equities and UK government bonds (or gilts).
Developed World equities are the one risky asset class we own that’s nudged back into positive territory year-to-date.
Our gilts remain substantially up.
Our other equity holdings were all spiraling down 20-30% last quarter but they’ve catapulted back to recover much of their loss, too.
Global Small Cap has bounced (like a dead cat?) up 30% while UK equities are the laggard, ‘only’ putting on 16%.
This is the kind of volatility we can all live with.
I’m not sorry we sold more than £3,000 of our bonds last quarter and ploughed the proceeds back into equities in a timely rebalancing move.
Return of the math
One thing that’s long fascinated me is how large your returns must be in order to recover from a steep fall versus a mere dip.
For example:
10% / 90% x 100 = 11% gain needed to recover from a 10% loss.
50% / 50% x 100 = 100% gain needed to recover from a 50% loss.
The Slow & Steady portfolio lost around 11% last quarter so we only needed just over 12% to tunnel back up to the surface.
The speed of a morale-boosting turnaround like that makes it a lot easier to remain calm if the coronavirus crisis has a few more downward legs in it yet.
The bottom line is that diversification into bonds has proved it’s worth to me in as visceral a way as I could experience.
Another bet that’s paid off so far is backing capital over labour.
After the Global Financial Crisis, it seemed probable to me that my income prospects were permanently impaired. I partially justified diverting a large percentage of my earnings into the capital markets as a way of offsetting a dark future for somebody who’s chance to break into the 1% had likely passed. (Around the moment I was born, I think).
Watching the indiscriminate bazooka-firing from out of the windows of the Federal Reserve et al, it would seem like I picked the right side. For now, anyway.
New transactions
Every quarter we throw £976 to the wolves of Wall Street and hope they eat somebody else. Our fresh meat chunks are split between our seven funds according to our predetermined asset allocation.
Royal London Short Duration Global Index-Linked Fund – OCF 0.27%
Fund identifier: GB00BD050F05
New purchase: £68.32
Buy 63.73 units @ £1.07
Target allocation: 7%
New investment = £976
Trading cost = £0
Platform fee = 0.25% per annum.
This model portfolio is notionally held with Cavendish Online. Take a look at our online broker table for other good platform options. Consider a flat-fee broker if your ISA portfolio is worth substantially more than £25,000.
Average portfolio OCF = 0.15%
If all this seems too much like hard work then you can buy a diversified portfolio using an all-in-one fund such as Vanguard’s LifeStrategy series.
Seekers after financial freedom like us don’t posture about the car we drive or plonk our new handbag or iPhone down in the middle of the table when we meet our friends.
But you do still see one-upmanship in this community:
“Call this a bear market? I don’t even look at my portfolio unless at least one major High Street bank has gone bust.”
“Call 15% a savings rate? That’s more like a rounding error compared to what I sock away by living in my tent in the Rhondda valley.”
“You call shopping at Oxfam frugal? I get Oxfam to donate its clothes to me!”
Okay, I exaggerate. But it’s with fondness. And only a bit.
To be fair, very few of us throw our net worth around without a few humble disclaimers.
Which is confounding, because I bet most of us would love to know more about how other people are getting on.
Not in a monetary game of phallic wonga-waving, you understand. More to put their words into context. And to get a better sense of our own progress on the journey.
Years ago, I used to spend many hours a day on investing forums. And it would drive me mad when a poster would reveal they’d bought this or that controversial stock, to the admiration – or the condemnation – of the peanut gallery.
You can have an opinion of the odds of a particular investment working out, of course.
Yet most posters were happy to ascribe bravery, stupidity, foolishness, heroism, and the like to the action, too.
Very rarely did we know what the investment represented to the person in question. They could be a multi-millionaire investing beer money, or a student investing their entire loan. Which matters.
Because unless you know somebody’s full financial picture – and the magnitude of the investment – you can’t say much about the dangers or prudence of their actions.
It’s similar in online Financial Independence circles.
Somebody will say, for instance, that they can get by on £18,000 a year.
They’ll be labelled delusional by people who don’t know how old they are, where in the country they live, whether they own their own home, whether they have dependents, and so on.
The flip-side is equally true, too. £50,000 a year doesn’t go half as far in London as in Hull.
ISA-sizer
So I’m sure many readers will be very glad to read through the latest ISA statistics to be published by HMRC.
If you’re anything like me you’ll immediately compare yourself to your cohort and ask yourself some serious questions about your life pat yourself on the back.
Maybe it hasn’t all been for nothing!
Only time will tell. But certainly it’s interesting to see how much others are saving, or how your total pot compares to others your age or earning the same as you.
And hey presto…
Average annual ISA subscription:
Pot size by age:
(Click to enlarge)
Pot size by income cohort:
(Click to enlarge)
Want more? You can download the full report from HMRC’s website as a PDF.
Passive investing champion Lars Kroijer is back with another trio of answers to your investing questions. Once again this is a collaboration between Monevator and Lars’ popular YouTubechannel.
This time we sent Lars some queries we’ve received in the Covid-19 era. As before, his answers are in both video and edited transcript form below.
Note: embedded videos are not always displayed by email browsers. If you’re a subscriber over email and you can’t see the three videos below, head to the Monevator website to view this Q&A with Lars Kroijer.
Should we try to avoid the obvious losers from Covid-19?
Our first question comes from Rachel, who asks whether the pandemic is a reason to avoid certain sectors that are going to be ‘obvious losers’ – or to hire a manager to do so?
Index trackers might be best for normal times, agrees Rachel, but these are not normal times?
Lars replies:
As I’m answering this question in June 2020, virus cases might be down but there is still a lot going on – lockdowns, severe travel restrictions, and rumors of remedies and treatments.
However there is not yet a vaccine and in fact, there is a threat of a second wave of infections.
The future is still highly uncertain. Economies face huge declines and certain sectors like travel and hospitality are facing massive impacts in the future.
So, the first questions really is, would you be able to pick a stock market sector to be an obvious underperformer? And my argument is you cannot. Shares in a lot of these sectors have fared incredibly poorly – but that is not something you know will happen from this point on.
Let us say you have one sector that has already gone from a hundred in value to twenty in value. Will that decline happen again? Not from hundred – but from twenty?
That is actually an incredibly bold statement, to say that you know this sector better than the trillions and trillions of dollars already invested and the very, very well-informed investors all over the world.
So no, I do not think you can pick these sectors to yourself. I recommend you stick with the broadest, cheapest, index tracking fund you can get your hands on.
What if you find a smart investment manager to avoid the bad sectors? Someone with access to all the right information, people, and so forth?
Well, in normal times, one or two active managers out of ten perform ahead of the relevant index over ten year periods, after all the fees and expenses they incur on top of what they charge you. You can argue that these are not normal times, but is it really likely that the 10-20% outperformers will become more than 50%? I do not think so.
Can you then pick one of the few investment managers who will outperform the market? Again, that is very unlikely. Past performance is not of an indication of future performance, so you can’t just pick the ones that have done well in the past, unfortunately!
So again, I think save yourself of all the fees and expenses and buy the broadest, cheapest, global index tracker.
Of course what is going to happen is once this plague is over, one way or another, some investment managers will have done very well. You should expect to see big billboards, and books written about them saying how they knew this or that what happen. But that is the winner’s argument. We are not going to see billboards, talk shows, and so forth highlighting all those that have not done well.
I appreciate the desire to do something in these turbulent times. You probably have a lot of other stuff going on economically. I’d strongly encourage you to look more closely at your personal financial circumstances.
We also know that equity markets are probably a lot more risky than they were before the coronavirus. This is a far more volatile market. If you want to reconsider your asset allocations, there are other videos in this series that address this issue.
What do low or negative rates imply for 60/40 portfolios?
The question in this video comes from Dave, who asks: if central bank interest rates go negative, what implications does that have for the 60/40 portfolio?
Lars replies:
First of all, the 60/40 portfolio refers to the idea of having 60% of your money in equities and 40% in bonds. The idea is this is a reasonable level of risk for a lot of investors. You have the upside in equities but you also have the 40% bond allocation to temper the risk.
My view is it’s great to keep things simple but risk is really quite an individual thing. It depends on the stage of your life, your non-investment assets and the correlation of these, and also just how you feel about risk, your job, and so forth.
So, the 60/40 might suit you – but do not assume it is for everyone. If you are interested, there are product providers like Vanguard and others with funds where you automatically get this – or a similar fixed – allocation.
Back to the question, and the answer, unfortunately, is not really clear. If you assume that the risk of the government is fixed, which is a big assumption, and that the equity risk premium does not change as a result of interest rate changes, then it is clear your expected investment return will be lower as a result of lower interest rates.
What does that mean in practical terms? It means you will expect to have lower investment income in the future if you keep the 60/40 investment portfolio. For those looking to retire, this means you will either have to save more, consume less, or work longer, which is obviously not great.
Of course you can exchange or expand your portfolio composition from 60/40 to invest more in equities. But all else equal, this will be a higher-risk portfolio. So you have got to make sure that you have the risk tolerance to do that.
In reality, it is not that simple. Central banks set their interest rates in response to the status and the prospects for the economy. It is a great tool to get the economy going. Their decisions on interest rates filter through to bond yields for investors, and obviously with lower interest rates there is an incentive to borrow more money and invest in the economy.
But can you assume that government risk is a constant? You cannot really assume that. You also cannot assume that the equity risk premium is a constant. It is also not really knowable.
The equity risk premium is generally deemed to be 4-5% above inflation. But it really changes dramatically with the changing of the risk of the equity markets. And it is also perhaps not a terrible assumption to say that in a lower interest rate environment where governments are actively trying to boost the economy that the equity risk premium may go up.
I should mention we are discussing here real interest rates, so that’s after-inflation. So if you have high inflation country, even with a 10% nominal interest rate and 9.5% inflation, that still means the real interest rate is only 0.5%. So there is no free lunch there.
But going back to the 60/40 portfolio, this video is shot in the middle of the pandemic and one thing is very clear – the risk and the equity market’s expected future volatility has varied dramatically and shot up massively.
So if you have kept a 60/40 portfolio, well the overall risk of that portfolio has changed a lot. In a sense it is quite an active choice to simply say you want to keep 60/40. So, just be sure you can stomach that higher risk.
Of course with higher volatility, it is not unreasonable to expect higher future returns. But that’s at the cost of the higher risk.
I would also say that the answer to this question would be clearer if you had a 100% bond portfolio. In that case, it is pretty clear there is no potential compensating factor from equities and you will simply earn less and have lower real returns for your portfolio, and you would have to adjust for or simply live with that fact.
In summary, I’m sorry the answer is not clear but I still hope my commentary was somewhat useful!
Do widespread dividend cuts mean equities are less attractive?
Finally, a question from Sandeep who asks whether the widespread dividend cuts we’ve seen affects my view on the attractiveness of equities as an asset class?
Lars replies:
This video is shot amid the Corona pandemic and a lot of companies have cut dividends because of the highly uncertain economic future.
But this does not really change my view of the attractiveness of equities as an asset class.
I’m not aware of any studies that suggest that a lower dividend yield will automatically lead to lower overall returns for equities going forward. And even if that were the case in the past, it is not clear that it would be the case in the future.
Now, ‘overall returns’ means both dividends and the capital gains from owning these stocks. And obviously, changes in the dividend are often seen as a sign from management as to how things really are. An unexpected lowering of a dividend will very often lead to a massive price drop. It is essentially management saying we do not have the cash to pay the dividends that we thought we did. That signal is very bad.
But it is also a very good assumption to say that market prices adjust quickly to these new circumstances. Therefore it is a very bold statement to say that you can outperform the market after dividend cut announcements by assuming it says something about the prospects for the wider markets.
Now, just talking briefly about dividend cuts in the Corona pandemic and what happened when the virus spread globally, quickly. What we saw was the market reacted much faster than companies around the world were announcing dividend cuts. So, those dividend cut announcements did not lead perhaps to the same magnitude of price movements you’d expect, because the market was already expecting these dividend cuts.
Of course, they were still surprises, both positive and negative, from the signal and effect of the changes to the dividends but nothing [to exploit as an edge] – certainly not for regular retail investors.
More broadly speaking, I would say some people like receiving dividends and others do not. For me that often has a lot to do with tax. Your specific tax situation, the jurisdiction you are in, and whether you want dividend or capital gains
Let us say you had a €100 stock that is paying €2 in dividends – after the dividend date, that stock should go €98. If you have a parallel situation where the stock did not pay dividends, you’d stay at €100. What is better for you depends on your tax situation, so that is worth keeping in mind.
Until next time
Please do feel free to add to or follow-up Lars’ answers in the comments below.
